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Have New Trading Hours Impacted Market Volatility?

The CME group's shuffling of electronic trading hours last spring had some folks wondering what would happen when the markets stayed open during what many view as the biggest potential for volatility – the monthly release of USDA supply and demand reports.

But Kansas City Federal Reserve researcher Nathan Kauffman, in a new report, finds that commodity trading during USDA reports may not present issues for producers who employ long-term trading strategies, and it actually could highlight the role of nonproducer traders.

"Producers typically oppose any change in market structure that affects their ability to mitigate exposure to price volatility," Kauffman explained in the report. "Conversely, non-producers often welcome price volatility because it provides them with an opportunity to profit from changing prices."

Likewise, when the time change was first released, it was met with mixed reaction. Producers were concerned that the open markets during report releases could lead to strong price spikes. Proponents of the changes, however, said it allows for greater modernization, market access and flexibility.

Kauffman notes in the report that while the initial disagreements abound, a look at the baseline trends on WASDE release days for December corn contracts shows that volatility is indeed higher on those days, though the frequency varied across years and has rarely affected long-term trends.

"The results suggest that there are periods of high intraday volatility that could pose challenges for producers making risk-management decisions, although markets appear to be reacting to, and processing, the new information relatively quickly," Kauffman writes.

Because the information is quickly consumed, Kauffman adds that it is "unlikely" that extended hours have significantly affected producers' risk management practices if the decisions are not dependent on intraday price swings.

Producers seeking to manage risk on the short-term, however, could be a different story.

For example, if one grain farmer uses stop-loss orders, Kauffman said, short periods of extreme volatility could push prices below a bottom threshold, triggering sales, but subsequently push prices back higher. That could cost a farmer significant returns, he notes.

Nonproducers' roles

Kauffman says aside from looking at the market trends on WASDE release days, long-term trends about market participation are also key to understanding the whole picture.

That starts with understanding nonproducer participation in commodity markets, which has grown since the early 1990s, when nonproducers held as little as 6% of total open interest in corn futures contracts. In 2012, it averaged 33%, Kauffman reports.

This participation by nonproducers has at least to some extent helped limit volatility because of increased liquidity and depth.

"Nonproducers frequently buy futures contracts that producers sell when hedging. This mechanism allows producers to lock in a price for their crop in advance, with nonproducers accepting the price risk that producers prefer to avoid," he says.

And that's why they like more volatile markets. "If prices stay constant, nonproducers have no way to profit in futures markets," Kauffman notes.

While other arguments for and against the change exist – such as speed of access to WASDE reports and interpretation of information contained in those reports – Kauffman says it is unlikely that WASDE reports alone will result in price spikes other than those recorded briefly in the middle of the trading day.